A major requirement in managing a fixed-income portfolio using a contingent immuniza- tion policy is monitoring the relationship between the current market value of the portfolio and the required value of the floor portfolio. This difference is defined as the margin of error. In this regard, assume a $300 million portfolio with a time horizon of five years. The available market rate at the initiation of the portfolio is 12 percent, but the client is will- ing to accept 10 percent as a floor rate to allow use of active management strategies. The current market values and current market rates at the end of Years 1, 2, and 3 are as follows:
End of Year
Market
Value ($ Mil)
Market Yield
Required Floor Portfolio ($ Mil)
Margin of Error ($ Mil)
| 1 |
$340.9 |
10% |
|
2
|
405.5
|
8
|
|
3
|
395.2
|
12
|
Assuming semiannual compounding:
a. Calculate the required ending-wealth value for this portfolio.
b. Calculate the value of the required floor portfolios at the end of Years 1, 2, and 3.
c. Compute the margin of error at the end of Years 1, 2, and 3.
d. Indicate the action that a portfolio manager utilizing a contingent immunization policy would take if the margin of error at the end of any year had been zero or negative.